Both investors and issuers are expressing concern over the role of bookrunners who submit early orders to support Asian bond issues.
Fund managers complain that new issues often fail, or sink in secondary, even when they come with big lead orders from the underwriting syndicate and books are said to be heavily subscribed. At the same time, issuers are questioning whether arrangers intend to honour their orders in full, especially if markets move against them during bookbuilding.
“Increasing balance sheet cost is putting huge pressure on investment banks to increase fee income. As a result investment bankers are bidding too aggressively for the mandates,” said Sanjay Guglani, chief investment officer at fund manager Silverdale Capital. “Later on, when they face the market, they are unable to throw their balance sheet to rescue their reputation. Hence, they renege on their soft commitments.”
Market participants pointed to aborted offerings from high-yield Indian and Chinese issuers as examples of deals that had failed despite indications of anchor investments by the lead managers.
Bankers said they did not see anything wrong with putting in an order, and that if anything it showed investors they had confidence in the deal. Furthermore, issuers often request an order to help get a deal done.
“Increasing balance sheet cost is putting huge pressure on investment banks to increase fee income. As a result investment bankers are bidding too aggressively for the mandates”
The practice has become more prevalent in Asia’s competitive bond market in recent years, especially on deals for Chinese issuers, who often push for hard commitments in return for mandates. But investors believe many banks have no intention of honouring their lead orders in full, arguing that including those orders at the start of bookbuilding distorts pricing and demand.
Soft commitments
Treasurers say that, before a bond prices, it is common practice for banks to promise to buy allocations, mostly to give deals the appearance of some momentum and size so as to encourage other potential buyers to participate.
Frequently this will happen at the request of an issuer. A treasurer at a large Chinese corporate told IFR that in a recent deal his company insisted that some of the joint global coordinators place orders, mainly as a way to get the book started.
In this issuer’s case there was substantial investor demand and no problems ensued, but his advisers warned him that sometimes JGCs refuse to take up their allocations, and if that happens the issuer is left with little recourse.
“We got the banks to do this with our eyes open,” said the treasurer. “If they had been forced to take up their allocation, it would not have been good. But that would have been preferable to a failed issue. And if they had refused to take up their allocation, and just let the issue fail, I would have made sure that it became public knowledge.”
Lawyers who have worked with banks and issuers on deals confirm that it is practically impossible to ensure that banks buy their full allocations. Until a deal actually prices there is little binding a bank to its allocation, apart from the potential damage to its reputation and client relationship.
There also seemed to be little sympathy for the issuers who are in effect playing the same game as the banks: to inflate the books to get as many orders as possible and achieve the lowest pricing.
“There are very few banks that would be willing to agree to provide unconditional hard underwriting,” said Connie Heng, head of capital markets Asia-Pacific at law firm Clifford Chance. “Even if for various reasons they agree to do so, the underwriting will usually be subject to conditions, including market conditions or satisfactory documentation. We see a few issuers asking their relationship banks to do this without appreciating that this may not be possible institutionally, and what they end up receiving is a soft underwriting commitment subject to conditions.”
Competition
Market participants have said privately that one of the main forces behind this trend has been the emergence of Chinese banks trying to gain market share.
Some Chinese banks have gone as far as promising to buy large allocations with no conditions, in addition to charging almost nothing in fees, in order to build up league table credit. As a result, rival Western banks are under pressure to follow suit.
The International Capital Market Association’s primary markets handbook states that during bookbuilding disclosures on investor demand should be clear and fair, and not mislead issuers and investors.
However, the handbook also encourages bookrunners to include force majeure clauses that allow them to exit an underwriting commitment in extreme cases.
